The monetary policy committee of the Reserve Bank of India (RBI) has cut the benchmark repo rate for the third time this year. It also changed the stance of monetary policy to accommodative from neutral. But if RBI intended for lower rates to stimulate the economy, it is not working. Growth is slowing.

Gross domestic product (GDP) growth fell below 6% to 5.8% in the March 2019 quarter. Annual GDP growth slowed to 6.8%, well below RBI’s expectation of 7.2%. Data for industrial production shows that industrial growth has essentially fallen to zero in the last two months. The slowdown in consumption—both durables and non-durables—is certainly a concern to decision-makers. The central bank has also revised down its growth estimate for the coming year.

The slowdown means that the economy is operating below its potential—known in economic jargon as a negative output gap. This has implications on pricing power, and inflation normally remains low if there is an output gap. Inflation as measured by the Consumer Price Index has risen recently, but remains below 3%, much lower than RBI’s target. Global developments since the last policy meeting—chiefly the US-China trade war and continued evidence of a global economic slowdown—further places downward pressure on commodities and global inflation in general.

As such, the outlook for rates has shifted in recent months across the globe. Yields on global bonds are at multi-year lows, and in Germany, the 10-year yield has hit its all-time low of -0.2%.

One aspect that is often forgotten in monetary policy debates is that the direct impact of interest rate changes are only on the rate of interest paid by banks to each other in the overnight market. The rates of interest on customer transactions, such as the fixed deposit rate or the lending rate (marginal cost of funds based lending rate) are only indirectly affected, as these also depend on provision of liquidity by RBI.

Importantly, the last two rate cuts have been accompanied by little or no changes to these rates, which actually matter more to the real economy. In fact, for several parts of the curve, yields have risen in recent months, at complete odds with the stance of monetary policy.

This has been due to very tight liquidity conditions in the financial sector. The NBFC (non-banking financial company) liquidity stress is well known and widely reported, but banks too have been facing their own version of tight liquidity. For the past two years, credit growth has been outpacing deposit growth rates. The absolute increase in bank credit during FY19 was about 99% of the absolute increase in deposits. This suggests that banks have not added any amount to liquidity buffers such as the statutory liquidity ratio (SLR), cash reserve ratio (CRR) and liquidity coverage ratio (LCR) during the past year. For FY18, that ratio was 112% implying that banks were dipping into their stock of SLR/CRR/LCR to make loans, and draining liquidity from the system.

RBI, on its part, infused nearly 3 trillion of liquidity through open market operations in FY19—the highest amount ever. But in the year before that, it had drained about 1 trillion from the system. Over the two-year period then, RBI only infused about 2 trillion, against a liquidity requirement of about 5 trillion (average annual requirement of 2.5 trillion).

A rethinking is required in terms of liquidity infusion if lower rates are to be transmitted to the real economy. To that end, it’s heartening that RBI has decided to constitute a working group to review the liquidity management framework. Similarly, the money market plays a key role in transmitting rates to the broader economy. Here, too, RBI has decided to review its various directions and create a comprehensive framework for the money markets.

R. Sivakumar is head of fixed income at Axis Mutual Fund.